Guest Columnist: Inflation figures in retirement savings

A retirement plan must address two important objectives: safely saving money while also outpacing inflation. The challenge is finding the right mix of investments to succeed at both objectives.

Jeffrey Thatcher

A retirement plan must address two important objectives: safely saving money while also outpacing inflation. The challenge is finding the right mix of investments to succeed at both objectives.

Offsetting inflation is one of the biggest challenges facing people saving for retirement. Over time, even a modest rate of inflation will significantly reduce a dollar's buying power. This means it is essential to have a retirement-savings portfolio that keeps pace with — or hopefully exceeds — inflation.

One way to do this is through asset allocation, a plan to diversify savings by having a mix of investments. Asset allocation refers to how you divide your savings among asset classes such as stocks, bonds and money market instruments.

An appropriate asset allocation plan offers the potential to pursue enough growth in savings to outpace inflation while also protecting enough savings to address your goals and provide retirement planning confidence. Asset allocation cannot completely eliminate the risk of fluctuating stock prices and uncertain returns, nor can this strategy ensure profit or guarantee against loss. However, it could provide less risk than being invested in only one type of savings vehicle.

Consider the cases of two hypothetical savers, Marco and June. They both set aside $5,000 per year for retirement. Marco puts all of his retirement savings into a very conservative investment option, such as a money market fund or insured savings account. These provide safe, reliable returns, but the yield tends to be relatively small.

June also is a steady saver, but she invests some of her money in stock funds, with the remainder in a mix of bonds and conservative cash investments. June recognizes that stocks offer the highest potential return, but they also carry a significant amount of risk. That's why she chooses some bond and stable value investments. They help offset any short-term losses in stocks.

Marco's money earns about 5 percent per year, while June's money earns an average of about 8 percent a year. If you assume that inflation averages 3 percent per year, who do you think will end up with more spending power in their account after 10 years?

Obviously, it's June. She ends up with the inflation-adjusted equivalent of $66,034, compared with $55,844 for Marco. (The inflation-adjusted equivalent is the future value of the account, in today's dollars. Inflation historically has averaged around 3 percent, but double-digit inflation isn't unheard of, as seen most recently during the early 1980s.)

Choosing an appropriate mix of stocks, bonds and cash investments in your retirement plan depends on your personal situation. Someone must carefully consider their savings goals, the number of years until retirement and their tolerance for risk.

Jeffrey Thatcher is director of HVFCU Financial Services, the personal-investment division of the Hudson Valley Federal Credit Union, which is based in Poughkeepsie.